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Sell This Popular Income Stock Now

The search for income takes investors to diverse places, and tobacco stocks have been a favorite for many months. However, all trends eventually come to an end, and that seems to be the case for the rally in Reynolds American (NYSE: RAI).

Since its early July peak, the stock is down about 7%. This includes a rather sharp sell-off on July 26 following the cigarette maker's disappointing second-quarter earnings report. The company missed both revenue and earnings estimates, and the post-earnings sell-off resulted in a technical breakdown through a rather important trendline.

This week, Cowen and Company reaffirmed its "outperform" rating on the stock, saying that weak guidance was already priced in, but the market is saying otherwise.

RAI has been lagging the broader market since February and shows no signs on the charts that this condition will change. There are plenty of other technical warnings in place, including the non-confirmation of the July high by momentum and volume indicators, but let's focus on the pure and simple trend break.

Reynolds started its long-term bull market in 2009 when the broader market bottomed. The rally accelerated in October 2014, and the trendline drawn from that point was broken to the downside last month.

Since the breakdown, RAI found some buyers at the 200-day average and spent the first half of this month correcting its decline. Shares rallied back to test the underside of the broken trendline, and this is likely where they will stall and resume their decline.

Chart watchers call this a test of the breakdown, and it gives late bears a chance to sell at or near the original breakdown price. And if the stock is truly broken, the drop should be swift once it resumes its decline.

While there is no guarantee RAI will fall, the weight of the technical evidence supports that conclusion.

Weekly charts show waning momentum tops, and stochastics broke support. Stocks in bullish trends usually see the stochastics indicator stay at high levels and only dip slightly on the inevitable ebbs and flow. So, when it falls to very low levels, we get an idea that something changed. In other words, we can expect the current bounce to fail rather than attempt a new high.

Should the decline resume, there is support in the $47.50 area from the April low -- a prior test of the trendline. But given the size of the bull run, it seems that a much deeper correction is warranted. Support from the late-2015 and early 2016 lows at roughly $45 provides a solid target.

If Reynolds can get significantly back above the trendline and erase its July 26 post-earnings sell-off, we'll want to exit this trade, so I'm placing a stop-loss at $53.

Note: While this income stock's rally appears to be coming to an end, there is an alternative income investment that's safe enough for retirees and can bring in $850 in income a week. Get the details here.

Recommended Trade Setup:

-- Sell RAI short at the market price
-- Set stop-loss at $53
-- Set initial price target at $45 for a potential 11% gain in six weeks